Recent adverse shock events have increased corporates’ awareness of the need to manage risks in both their physical and financial supply chains, and for many of them, supplier counterparty risks have now come to the fore. Liz Salecka reports.

Corporates worldwide are exposed to a variety of risks in their supply chains, including operational risks, counterparty risks and political risks – all of which can impact their ability to meet their production and delivery targets, satisfy customer orders and effectively manage their cash flows.

The main concern for most companies is around continuity of supply. This also extends to financing as we saw in 2008/09 when liqudity dried up quickly, emphasising the need for diversity.”

As financial supply chains have gained increased importance at board level – for providing the means to unlock spare cash at a time of more limited access to bank credit – risks to their efficient operation management have also become the subject of greater attention.

A global survey of companies in multiple business sectors revealed growing awareness of financial supply chain risks, with customer counterparty risks (27%), foreign exchange risks (27%) and operational risks (30%) considered the single biggest concerns. Surprisingly, risks to supplier financing, came much further down the ladder with only 6% of respondents identifying this as the biggest threat.

The real risks

According to Ashutosh Kumar, global head, local corporate products and receivables, Standard Chartered, although corporates face a variety of risks in both their physical and financial supply chains, supplier bankruptcy, failure or downtime represent the most serious threats to a company’s business.

“One of the greatest risks companies are exposed to is not being able to get the supplies they require on time. If you cannot gain access to the materials you require, you will have to stop production and this can result in major losses for your business,” he says.

Michael Lim, global head, structured trade finance, ANZ trade and supply chain adds: “The main concern for most companies is more around continuity of supply. This concept also extends to financing as we saw in 2008/09 when liquidity dried up quickly. This emphasises the need for diversity of supply in inputs as well as in liquidity.”

Since the survey was conducted, the importance of managing supplier counterparty risks has been emphasised by recent shock events such as the tragic tsunami in Japan, and the political upheaval and unrest witnessed in the Middle East, which have impacted the physical and financial supply chains of many large corporates.

For example, car manufacturers Honda, Nissan and Toyota, were forced to cut back production and working hours at a number of their European factories because of their dependence on key components, made in Japan, whose assembly and delivery has been severely impeded.

According to ANZ’s Lim, many of the problems experienced in the wake of the Japanese tsunami stemmed from major companies’ reliance on lean levels of inventory.

“Many Japanese companies have extremely efficient supply chains which allow them to carry minimal stock as a result of their just-in-time inventory arrangements,” he says. “The tragedy in Japan decimated these supply chains. While the scale of the disaster couldn’t have been predicated, it reinforces the need for disaster recovery planning and having alternate means of supply.”

Events like unrest in the Middle East have impacted bottom lines.”

Jonathan Heuser, head of trade advisory and solution delivery, Asia Pacific, JP Morgan treasury services, believes that the recent shock events have made companies more aware of the pitfalls of following procurement strategies, which are centred on streamlining supply chains to save costs, improve efficiency and reduce the level of working capital tied up in inventory.

“This approach shows its drawbacks during periods of turmoil or crisis events with disruptions to the supply chain resulting in a lack of product availability and an interruption of operations,” he says. “With our global economies increasingly inter-linked, events like the tragic earthquake and ensuing tsunami and nuclear crisis, and the recent unrest in the Middle East and North Africa, have impacted not just the headlines but the bottom lines of those companies doing business across borders.”

Need for more risk management

Heuser argues that recent events have made companies more aware of the need for thorough supply chain planning, which involves ensuring supplier diversification, holding adequate levels of inventory to withstand shock events, managing counterparty risks and having an appropriate supply chain finance strategy in place.

“Whether disruption is caused by financial failure, political unrest or a natural disaster is not the point; the damage to the business is the same. A supply chain will almost always inevitably encounter some level of crisis. This means that the benefits of applying thoughtful risk management to both the physical and financial supply chain will always far outweigh the costs.”

Dominic Broom, managing director, treasury services, Bank of New York Mellon, agrees, pointing out that many companies are now becoming increasingly conscious that a cost-driven approach to procurement has left them dependent on suppliers which are concentrated in too few markets.

“Companies are having to reposition their supply chains and are recognising that cheaper production should not be the sole driver,” he says. “Having diversity in a supplier network is one of the best ways of spreading risks. In general, having a back-up plan, and being able to switch activities from one location to another is needed.”

Oil price impact

Broom notes that many companies were equally unprepared for the recent hike in oil prices and, after having outsourced production to lower-cost economies in distant parts of the world, they now have to meet much higher transport and shipment costs.

Aside from revisiting the physical location of their suppliers, he also advises that companies reconsider the route that the parts or components they source must take to reach them.

“Political difficulties in one particular country can affect the routing of traffic, as proved to be the case for a number of companies during the recent unrest experienced in Egypt,” Broom says. “Companies need plans in place so that they can respond to situations like this.”

Standard Chartered’s Kumar also notes out that recent shock events have led many companies to re-evaluate and rethink their business continuity strategies and disaster recovery plans in relation to their supply chains – and realise that one of their biggest areas of attention is the geographic location of their suppliers.

Many corporates are also much more interested in talking to both their suppliers – as well as their suppliers’ suppliers – to make sure that they can withstand a crisis in the future.

“They are rethinking their own business locations with a view to spreading their risks from a geographic perspective. They are also re-examining their supply chains to see where they may be prone to risk,” Kumar adds.

Supply chain finance needs

Recent shock events have also led to an increased focus on ensuring the financial stability of suppliers and the need to make supplier financing available when and where it is needed most.

Kumar explains that in recent years, large corporate buyers have not only sought to secure a stable source of financing for their suppliers in Asia, but have called for financial solutions that can be adapted to meet their changing business requirements. Many banks have responded to this with solutions that allow the level of supply chain financing provided to be adjusted in line with the peaks and troughs in buyers’ businesses.

He argues that banks can take this concept one step further by helping large corporates, which have structured supply chain finance programmes in place, secure the stock they need in a crisis by enabling them to procure more from those suppliers whose business is not interrupted.

“If a company depends on five suppliers in five markets and one of them goes down in the event of a crisis, they can replenish their supplies from the remaining four suppliers. The latter will simply need to produce more,” he explains. “For buyers, who are taking advantage of supply chain finance, and working with one bank to arrange financing for a range of suppliers in different markets, the option to extend financing to certain suppliers when required is there.

“At present, many companies are still trying to gauge the impact of the disaster in Japan on their supply chains, but they are entering new discussions with their banks to see how they can deal with this,” Kumar continues, adding: “I believe that in due course, demand for supply chain finance will increase as companies seek to ensure that their supply chains are as closely knit as possible, and that the financial stability is there to withstand shock events.”

BNY Mellon’s Broom also points out that suppliers can benefit from improved access to liquidity if they are part of a large business chain.

“There is enormous value in being part of a global supply chain programme if there is a major crisis, which brings significant perils and risks to a business,” he says, pointing out that the current unrest being witnessed in the Ivory Coast has led to local bank assets and banks services being frozen, and that in situations like this, being part of larger financial supply chain programme can alleviate the concerns local suppliers face.

“A smaller supplier’s value is accentuated if it is an established member of a large end-to-end business chain in which relationships are strong.”

Like Kumar, Broom also believes that suppliers which are part of a supply chain finance programme could benefit from access to more funding if they were required to boost their production in the event of a crisis.

“If a supplier, which is a member of an established and documented supply chain finance programme, is awarded more business as a result of supplier downtime in another country, then it will be in a better position to secure the additional funding needed from its local bank,” he says.

Broom points out that, with the exception of specific commodity finance structures, it may prove difficult for global banks to provide this type of pre-production or pre-shipment finance in the event of a crisis because it often requires a banking presence on the ground.

As a result, he advises major corporate buyers to further safeguard their overseas suppliers’ access to funding by building stronger relationships with local banks.

“These institutions typically hold the key to liquidity and transaction management for those suppliers,” Broom says. “It is important not to disenfranchise them [local banks] and try to do everything at a global level. Local banks tend to have a better understanding of local issues, transaction risks and credit risks in a given market.”

Meanwhile, ANZ’s Lim points out that while ensuring access to alternatives sources of supply can help corporates minimise risks to their physical supply chains, they can also benefit from structuring arrangements, which enable them to access liquidity from other sources if needed.

“Structures can be built to source liquidity from alternate jurisdictions,” he says, pointing out that banks can help minimise risks to liquidity flows with arrangements that enable suppliers or buyers to gain access to finance from alternate jurisdictions where liquidity is greater.

Convergence solutions

The recent shock events have also caused many companies to reconsider their overall approach to risk management.
This is expected to heighten the movement towards their adoption of converged solutions for cash and trade, as well as other business activities such as FX.

“There is now a much greater focus on managing enterprise-wide risk and many companies are taking a more holistic view of the risks they face, rather than looking at each type of risk individually. Although it is still early days, the recent crisis could strengthen the need to adopt converged solutions,” says Farooq Siddiqi, head of transaction banking for Mena at Standard Chartered.

“The more efficiently a company manages its entire working capital cycle and its supply chain, the greater its ability to mitigate risks. By converging their cash and trade activities, companies can make their supply chains more efficient,” adds Kumar.

Banks themselves can also benefit from improved risk management if their corporate customers adopt converged solutions.

“Converged solutions can help banks mitigate risks and do more for their corporate customers than if they were working in silo with different departments within a corporate. If a core bank understands the whole supply chain, it has a better understanding of the risks involved,” concludes Kumar.

BNY Mellon’s Broom also acknowledges that advances in technology, such as the single treasury platform, can not only help companies manage their liquidity, but identify any risks to their liquidity and their wider business.

“In adverse economic situations, such as the eurozone debt crisis, a converged solution can really help companies achieve major improvements in their liquidity management,” he says.

“Up until three to four years ago, the role of the treasurer tended to be focused on the collections side of the business, but now they can look at the end-to-end process and bring procurement under their sphere of influence.” GTR 

The Middle East responds to crisis

The recent political unrest in the Middle East has increased awareness of both supplier and customer counterparty risks, and many of the region’s trading companies are now working closely with their banks to mitigate the impact of future shock events.

The crisis has caused many of them to re-evaluate their physical supply chains to assess if they are holding enough stock in sufficiently diverse locations – as well as the geographic spread of their suppliers. It has also emphasised the need for ready access to receivables financing to deal with shock events.

“Both regional and multinational companies have had to revisit the way they run their supply chains,” explains Farooq Siddiqi, head of transaction banking for Mena at Standard Chartered. “Many companies are now talking to us about their contingency plans, and this has now come to the fore with supply chain management. They are considering how they can make use of alternative sources of supply if their supply chains are disrupted again.”

Siddiqi explains that the recent crisis has impacted the financial supply chains of Middle Eastern companies in varying degrees, depending on their business sector. Companies in industries such as automobiles, are now likely to be holding more unsold stock – and sitting on more receivables – and this has led to an increased awareness of the need for receivables financing.

“As the situation improves and sales recover, this will heighten the need for receivables financing,” he says. “One question that arises is the appetite of banks for this type of financing, but if banks have taken a long-term view on a particular market, then they will step in and support their corporate customers.

“However, there is likely to be more ‘give and take’ now as banks seek to share the risks involved with their corporate customers.”

Many Middle Eastern companies are also more conscious of customer counterparty risks, and this has heightened the need for letters of credit in trade transactions. Exporters and suppliers to the Middle East are also increasingly asking for letters of credit to mitigate risks, particularly when dealing with companies based in those countries, which have experienced sovereign or bank downgrades as a result of the crisis.

Suresh Vaidhyanathan, group CFO of Platinum Corporation FZE, which is headquartered in Dubai, believes that traditional letters of credit will continue to be used extensively across the Middle East for the foreseeable future, and that their importance has been accentuated by recent events.

“Letters of credit still play a major role in the region and form the primary risk mitigation for exporters and importers involved in cross-border trade,” he says, pointing out that he believes the recent political unrest may curb the movement by many Middle Eastern companies towards open account trading.

“What we are seeing is continued extensive use of letters of credit to provide a guarantee of payment,” adds John Wartig, group director, finance, Al-Futtaim Group in Dubai.

“It is too early to tell whether the recent Middle Eastern crisis will lead to greater dependence on letters of credit. Egypt has just opened for business, and in many of the countries affected, cross-border transactions generally are still very difficult to enter. However, this is certainly likely to reinforce the need for letters of credit.”

He also points out that overseas suppliers to many Middle Eastern companies have remained keen to retain letters of credit to guarantee transactions.

“More robust documentation is now required generally for all transactions, whether for trading activities, projects or financial transactions,” Wartig says. GTR